Posts Tagged ‘inflation’

The Bank of New Zealand’s chief economist Tony Alexander is a respected commentator regarding all aspects of New Zealand’s economy. If you would like to subscribe to his informative weekly economic commentary click here.

This week (Jan 20th 2009) Tony shared his view about the property market by putting himself in the shoes of a house-buyer:

I might have had a look at buying a property 12 or 24 months ago but found that the numbers simply did not stack up because the debt servicing cost was too high. But I would run the numbers again assuming a 5.5% five-year fixed interest rate and see what affordability of my preferred property would look like. The chances are that a very large number of people are going to find property extremely affordable this year and this is likely to add to demand and therefore limit the downside for prices.

The 5 year fixed 5.5% interest rate Tony talks about is a rate he predicts will occur before the end of 2009.

My personal opinion is that that rate should be” jumped on” when it occurs because I quietly suspect that 10% plus interest rates might be the norm from 2011 onwards. The great thing about a blog is that you and I will be able to re-visit this post to see if I was right or wrong!

I would like to share with you some of my views on the current global financial crisis.

Like me, during these turbulent financial times, you’re probably keen to stay positive and trust that you and your family will survive and thrive over the next few years. Many people are tightening their belts. I think you’ll agree there is a degree of uncertainty in the air. Some people prefer to bury their heads in the sand in the blind hope that our politicians will do their job and clean up the mess. After all, we elect and remunerate politicians because they know what they’re doing, right?

In 2007 while searching the internet for information about the US sub-prime crisis, I stumbled upon a US Republican Senator named Ron Paul. I was keen to stay informed about the meltdown’s possible flow-on effects for the New Zealand housing market. Ron Paul was one of the lesser known candidates running for the Presidency. During his campaign his policies were considered so radical that the mainstream media largely ignored him. Ron Paul is a Libertarian, a strong believer in the US Constitution. Consequently he is an advocate for smaller less complicated Government, low taxes, a productive export based economy and reform of the monetary system (possibly a return to the Gold Standard abandoned by Nixon in 1971).

Watching Youtube videos showing Ron Paul’s TV interviews, debates and congressional talks, I started to get a real sense of how the US (and the world) got itself into the current financial state. Led by the US, the entire world had been on an unprecedented spending and borrowing frenzy. Money was so easy and cheap that almost anyone was permitted to borrow, with scant regard to whether or not they could repay their debts.

On Youtube there is a remarkable exchange between Ron Paul’s economic advisor, Peter Schiff and an ex-Ronald Reagan economic advisor named Art Laffer. Schiff was warning about a future major economic collapse led by a housing downturn. Laffer completely discredited Schiff’s prediction, instead pronouncing that Americans were much richer due to the increased equity in their homes and a buoyant economy. The bombshell for me was that this CNBC interview took place in 2006!! In spite of so many disbelievers, Ron Paul and Peter Schiff had been spot on with their meltdown predictions. I had to know more. Why wasn’t Ron Paul the new President? I had a lot of questions.

There’s not a day goes by that I don’t question my thirst for more knowledge about this credit crisis. I refuse to allow it to effect my positive outlook on life and it’s pretty much business as usual for me. It’s just that I like to know what’s going on around me, so that I can make educated decisions now and in the future. Above all, I want to make sure my family will always be safe and well.

I researched the Great Depression to see how the lead up to the 1930s was different to 2008. You could do it too. Wikipedia was my source, and what I discovered was that there were many similarities between then and now. However, as I see them, two big differences are as follows:

a.Today’s personal and government debts are much bigger. The official US national debt is approximately $11Trillion. It’s probably much higher. It may never be repaid.

b.The speed of news & information could cause consumer spending to slow even quicker today than it did in the 1930s.

When consumer spending slows, businesses close their doors and unemployment and stock inventories rise. Prices, profits and wages fall. Deflation is occurring right now. You can see it all around you. To encourage people to spend, interest rates are falling through the floor. Deposit rates are falling too, so term deposits are looking less attractive and some property slightly more attractive. But the age old question springs to mind – where is my money safest?

Recent Government bailouts were enacted in the hope of boosting consumer confidence. Governments (US, NZ and others) hope that you and I will keep spending and borrowing just like we did before the credit crisis. But hang on. Isn’t spending and borrowing (too much) what got us into this mess in the first place?

Most Governments (particularly the US) are fixing the problem by adding to the problem. Most of them actually want to blow the debt-fuelled bubble up again, rather than have the recession (or depression) they need to have. Recessions clean out inefficient companies and bad practices. Think General Motors, Ford, etc. They’re inefficient behemoths that probably need to fail then re-structure. After pain there will be gain, but I think it’s logical that we must suffer the self inflicted pain.

A problem for Governments is that you and I are quickly realising that something is not quite right. We’re reducing spending, not borrowing and worried that if the boss can’t pay his bills, how can he pay us? If you are the boss, and you haven’t laid people off already, you’re possibly stressing about how you’ll tell your employees that you can’t afford them anymore. Am I striking a chord now?

Maybe you’re different. Maybe you’re super wealthy. Maybe your industry thrives during downturns. If that is you, you’re in the minority. Good on you.

Sorry back to reality though. So what do Messrs Paul and Schiff think is going to happen next? After all, they’ve been absolutely correct so far. According to them we will see a major collapse of the US dollar sooner or later. One way of explaining why this is likely is to discuss the value of money.

Until 1971 the Gold Standard effectively controlled how much money Governments could print. The more wealth a country accumulated the more gold it could buy and hold in reserve. When the gold standard was dropped the Fiat currency system was adopted and, by default, the US dollar became the world’s reserve currency. Oil and many other commodities have been traded in US dollars ever since. Until now, US dollars have always been seen as a strong and stable currency acceptable in almost any country in the world. With good reason I believe, Schiff & Paul think that’s all about to change.

Back in the 1600s the counterfeiting of money was an offence punishable by hanging. Goodness how times have changed! It’s still illegal for you and me to print our own money, but it’s perfectly okay for Governments to do it. The process of money creation is more complicated than I have space to explain (or understand), but invariably when Governments find themselves short a few billion dollars there is absolutely nothing, other than ideology, stopping them from creating it out of thin air. How convenient, strange, alarming, but true!

Guess what happens to the value of a dollar in circulation when you print a whole lot more dollars? The value of the dollar is eroded because it’s not so precious, unique and special anymore. Until a few years ago the US treasury was required by Congress to report how many dollars were in circulation. The measure of money supply was called the M3. Guess what happened to the M3? A few years ago it disappeared and Congress conveniently ignored the fact that the Treasury wasn’t monitoring & reporting it anymore. The M3 is a distant memory and the printing presses roll on to cover the bailout funds required to save failing companies and banks (and perhaps homeowners).

All drugs have side effects however. A serious side effect of printing vast amounts of money is inflation. In recent times Zimbabwe offers the most extreme example of this phenomenon. Hyper-inflation has destroyed that country’s currency so badly that the last reported inflation rate in July 2008 was around 216,000,000 percent. People in Zimbabwe can’t afford to buy anything outside their country because they are bankrupt. And who would want to own the currency of a bankrupt country?

Strangely enough it seems that he whole world is hungry to buy the currency of a bankrupt country. That country is the USA! Why?

Let’s look at China for example. China is the world’s fourth largest economy and has been growing at double digit rates for years. Because the US was perceived as having such a strong economy, China has invested approximately US$2.3 Trillion of their hard earned wealth in the US by buying US bonds/treasuries. For their investment, the Chinese get a decent “Government guaranteed” interest rate on their money over short and long terms. What has America done with China’s money? They’ve spent it! If China doesn’t ask for it back on maturity the US can breathe a huge sigh of relief. But in the meantime, with a sinking economy and bailouts galore, where does the US get the cash to pay China interest (let alone the principal) on the hard earned cash they “lent” to the US? Just counterfeit it! What a mess.

The US is no longer producing goods that the world wants to buy. Whatever they do produce is too expensive. Cars from Asia are better and cheaper. So how does China get paid the money they are owed? They either wait until the USA once again becomes an economic powerhouse through productivity and saving (a very long wait?); they sell out of their US dollars and assets (dollar plummets); or they forcefully take a chunk of US real estate (no more wars please!).

In conclusion

The disease currently afflicting the US (and most of the world) is debt finance consumption. The cure is to stop consuming and start saving and producing again. That means a recession – a normal economic phenomenon. Sometimes medicines taste bad but they must be taken.

I think we’re very lucky here in New Zealand that our Government wouldn’t be stupid enough to embark on a panic driven bailout frenzy to prop up failing financial institutions and public companies. Generally speaking I think Australians and New Zealanders are a more careful and resourceful bunch. The sizes of our Governments are manageable. If our economy gets into serious problems we’re unlikely to try to fix our problems by re-inflating the bubbles that have just been pricked. We’ll ride through the storm without needing to print enormous sums of money. With this prudence we’ll probably avoid a significant devaluation of our currency. I am a strong believer however that New Zealanders need to embrace the saving habit with gusto.

We can learn a lot from failure. The German Weimar Republic suffered from hyperinflation in the 1920s. Here is a Wikipedia extract from which you can see striking similarities to the current situation in the US. Judge for yourself:

“The 1920s German inflation started when Germany had no goods with which to trade. The government printed money to deal with the crisis; this allowed Germany to pay war loans and reparations with worthless marks and helped formerly great industrialists to pay back their own loans. This also led to pay raises for workers and for businessmen who wanted to profit from it. Circulation of money rocketed, and soon the Germans discovered their money was worthless.”

If you’ve taken the time to read my thoughts (and they are mine only) on the current economic crisis, I thank you sincerely. My motivation for including this in my blog is that you might be better informed or perhaps you will do some further research. If I have sparked your interest I would strongly recommend you have a look at some of Peter Schiff’s videos on Youtube.

Postscipt July 2009 – Has anything changed to make you think things will be any better or worse than how I described the situation 8 months ago? Eerily, most of what I described has proven correct, though substitue Chrysler for Ford!

Postscript December 2009: One year on – Countries throughout the world jumped on the “green shoots” bandwagon about six months ago. Many countries signalled the official end to their recessions when they reported postive quarterly GDP growth at the end of September. France, Germany and the USA were out of recession and things were looking up. The UK was less fortunate and entered its sixth consecutive quarter of negative GDP growth. Some economists define a depression as eight consecutive quarters of negative GDP growth. By April 2010 there is a strong possibilty the UK will move from recession to depression.

Remarkably, Australia narrowly avoided recession by dipping into negative GDP growth for only one quarter. The outlook is looking so rosy there that Australia became the first major economy to increase interest rates after a prolonged period of stimulatory world interest rate reductions. In contrast to the economies of the UK and USA, Australia has much that the developing world (led by China & India) wishes to purchase.

With massive debts and ongoing deficits, increasing unemployment and sluggish asset prices, both the UK and USA seem increasingly likely to enter a prolonged period of economic woe. The standard of living in those countries is likely to suffer, not unlike Japan since the 1990’s, largely as a result of low interest rates and currency depreciation. Put simply, if the US dollar falls in value relative to other currencies, it becomes more expensive for Americans to purchase goods from abroad. If the dollar continues to depreciate, Americans travelling overseas will find that everything overseas is very expensive. If a currency is predicted to lose value, human nature dictates that fewer countries, institutions and individuals will invest in it.

Capital flight appears to be gaining momentum and could gather steam in the months ahead. Already many Americans and several countries are exchanging their paper dollars for gold bullion. Paper money that could soon be worth less is migrating into a precious metal that could soon be worth more.

I could go on forever here but I want to leave you with a sobering thought. The official debt clock of the USA is a scary instrument. I’m not certain about its accuracy but I do know that the total national debt figure mirrors the official clock in New York’s Times Square. When I wrote this on Dec 5 2009 the US national Debt figure at the top left of the screen was approx $12,080,856,860,000,000. That was almost $12.1 trillion and rising rapidly.

Sorry to let you know an even more sobering statistic. One trillion seconds is equal to 32,000 years!

And if that’s not enough to convince you that any ‘green shoots’ news is a load of BS and that you should ditch any US dollars and put your money somewhere safe, check out this pre-Obama January 15th 2008 ’60 Minutes’ interview with David Walker the Comptroller of the USA who announced his resignation a month after this interview aired. He now heads a new organisation that aims to stop the rot by forming a special commission to address the looming crisis.

Update 25th June 2010: Gold is around US$1250 an ounce with many thinking it will go to $6000. Greece has been bailed and may soon default. Europe is shaky and austerity measures are being protested against in Italy and France and other European countries. The Europeans are calling for massive belt tightening and saving to pay down debt and prevent defaults; while the USA is now drowning in debt to the tune of $13.1 Trillion and calling for more stimulus spending as a better option to kick start the faltering economy. Recent Fed comments indicate to me that the US Government probably knows that they face either hyper inflation or deflation including a severe drop in the standard of living of all its citizens. In Australia Kevin Rudd has just been overthrown as Prime Minister. My big prediction for the second half of 2010 is growing political and possibly civil un-rest in Europe but particularly in the USA as more and more of their citizens wake up to the fact that the nation is flat broke and faking optimism so that the beauracrats and politicians can keep their jobs. The truth is now too hard to swallow. For Obama I believe honesty would be the best policy but the chances of seeing that are probably a trillion to one. I predict US national debt of around $14 Trillion by the time I post here again in December 2010.

Update 19 June 2011 – The Greeks were bailed out last year by the IMF and ECB to the tune of $110BN Euros. Big news right now is that, having kicked the can down the road, they probably should default right now but may not. If they make more cuts they’ll get more bailout money. I doubt the Greek PM can hold on (there are new austerity riots there) and I see a default coming and change of Govt. By this time next year the Greeks could (should) be using the Drachma and could (should) be on the road back to prosperity. That’s a big could and should. A default would probably start a contagion and Ireland, Portugal, Spain and Italy might as well default on their debts as well…and of course the Euro would be dead and buried. The wildcard is the yanks whom are now at $14.44Trillion and needing another debt ceiling raise next month – which they’ll get only so the politicians can keep their jobs and get paid. The USA has had bailouts, QE, QE2 and probably a lame form of QE3 about to be announced by the Fed. In anyone’s language they are printing money like a bankrupt alcoholic would so that their neighbours are none the wiser. Problem is you can smell the alcohol and the neighbours are no longer interested in their bank notes. Gold is currently at US$1540. I just swapped some NZD that are reducing rapidly in value (ie: prices of everything we buy are increasing) and bought some gold (I bought silver 2 years agoo that has virtually tripled in value) and stashed it away for a rainy day. I figure by the time my kids are in the fifties the small amount of precious metals I have accumulated could be worth a house! Watch this space for the update I post in 40 odd years :).

What does the next 12 months hold for us? More kicking the can down the road by Governments too scared to face the truth and default. This debt is like an addiction. Going cold-turkey is the only cure but doing so is very very hard – almost impossible. More debt bubbles due to easy money flowing out of the USA and Europe (NZ recently took a big swig of this alcohol by openly borrowing more than we need for a rainy day). Bold prediction but I reckon inflation will really kick in – at a reak rate of more than 10%pa. Interest rates will rise, causing more public and private defaults. Precious metals will rise as the ridiculousness of fiat currencies and cash hits home.